The equilibrium effects of a temporary increase in government spending include
A) an increase in the real wage and an increase in the real interest rate.
B) an increase in the real wage and a decrease in the real interest rate.
C) a decrease in the real wage and an increase in the real interest rate.
D) a decrease in the real wage and a decrease in the real interest rate.
E) real wages and the real interest rate remaining unchanged.

Question

Quizplus · Accepted Answer

When there is a temporary increase in government spending, it causes an increase in demand for goods and services. This increase in demand leads to an increase in prices and an increase in the cost of production. In turn, this will cause a decrease in employment, which leads to lower output and a decrease in the real wage. At the same time, the increase in demand will lead to an increase in the real interest rate, to encourage savers to supply more savings to the credit markets in response to the increased government borrowing.

The Equilibrium Effects of a Temporary Increase in Government Spending